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Insurance against Downside Risk for the U.S. Economy James Bullard President and CEO 2019 Monetary and Financial Policy Conference Oct. 15, 2019 London, United Kingdom Any opinions expressed here are my own and do not necessarily reflect those of the Federal Open Market Committee. 1 Introduction 2 Key themes • The U.S. economy is slowing down relative to 2017 and 2018. • The economy faces downside risk that may cause the slowdown to be • • • sharper than expected. A sharper-than-expected slowdown may make it more difficult for the Federal Open Market Committee (FOMC) to achieve its 2% inflation target. The FOMC has tried to help insure against this downside risk by dramatically altering the path of monetary policy during 2019. The FOMC may choose to provide additional accommodation going forward, but decisions will be made on a meeting-by-meeting basis. 3 A Slowing U.S. Economy 4 Slower growth • According to the most recent figures on U.S. real GDP, the economy • • grew at a 2.5% pace during 2018. Growth for 2019 as a whole has long been expected to be slower as the economy returns to its potential growth rate. The key risk is that this slowing may be sharper than anticipated. 5 U.S. real economic growth Sources: Bureau of Economic Analysis and Federal Reserve Board. Last observation: 2019-Q2. 6 Downside Risks to Growth 7 Downside risks to growth • It is possible that a sharper-than-expected slowdown could materialize in • the quarters ahead. The downside risks, possibly interrelated, include: o The effects of magnified global trade policy uncertainty o Slowing growth in the global economy o Contraction in global and U.S. manufacturing o Slowing U.S. business investment o An inverted yield curve, which seems to suggest U.S. monetary policy may be too restrictive for the current environment 8 Ongoing trade disputes • Ongoing developments suggest that it will be difficult to reach a stable • • global trade regime over the forecast horizon. Trade regime uncertainty is likely chilling global investment and feeding into slower global growth. The direct effects of trade restrictions on the U.S. economy are relatively small, but the effects through global financial markets may be larger. 9 High trade policy uncertainty Source: www2.bc.edu/matteo-iacoviello/tpu.htm. For details, see D. Caldara, M. Iacoviello, P. Molligo, A. Prestipino and A. Raffo, “The Economic Effects of Trade Policy Uncertainty,” Federal Reserve Board International Finance Discussion Paper No. 1256, September 2019. Last observation: October 2019. 10 U.S. monetary policy and trade • U.S. monetary policy cannot reasonably react to the day-to-day give• • • and-take of trade negotiations. I think of trade regime uncertainty as simply being high in the current environment and as something that is already being judgmentally factored into my monetary policy calculus. Particular threats or counterthreats are only manifestations of already high trade regime uncertainty. I do not expect this uncertainty to dissipate in the quarters and years ahead. 11 Slowing global growth • Trade policy uncertainty creates a disincentive for global investment. • Accordingly, the global growth environment looks weaker in recent • quarters. Slower global growth may feed back into slower growth in the U.S. 12 Slowing global growth: The OECD outlook 2019 2019 2018* projected projected in May 2019 ** in Sept. 2019 * (1) (2) (3) Worsening projections: Difference (3) − (2) 2018-2019 slowdown: Difference (3) − (1) U.S. 2.9% 2.8% 2.4% −0.4% −0.5% Euro area 1.9% 1.2% 1.1% −0.1% −0.8% U.K. 1.4% 1.2% 1.0% −0.2% −0.4% Japan 0.8% 0.7% 1.0% +0.3% +0.2% China 6.6% 6.2% 6.1% −0.1% −0.5% Growth rates are year-over-year; differences are expressed in percentage points. Sources: * Organisation for Economic Co-operation and Development, Interim Global Economic Outlook Assessment, September 2019; ** Organisation for Economic Co-operation and Development, Global Economic Outlook, May 2019. . 13 Global manufacturing contracting Source: IHS Markit/JPMorgan Chase. Last observation: September 2019. 14 U.S. manufacturing stalling Sources: Federal Reserve Board, Institute for Supply Management and author’s calculations. Last observations: August 2019 and September 2019. 15 U.S. business investment slowing Source: Bureau of Economic Analysis. Last observation: 2019-Q2. 16 Yield curve inversion • The slope of the yield curve contains important information for • • monetary policymakers. An inversion of the yield curve has tended to predict the onset of recession in the U.S. during the postwar era. Some portions of the U.S. Treasury yield curve are inverted today. o In particular, the 10-year yield is below the effective federal funds rate. o However, the 10-year yield is currently above the two-year yield, likely because markets are anticipating future policy moves by the FOMC, and so we are not seeing an intensification of the yield curve inversion so far. 17 Yield curve partial inversion Sources: Federal Reserve Board, Bloomberg and author’s calculations. Last observation: Week of Oct. 9, 2019. * For details, see E. Engstrom and S. Sharpe, “The Near-Term Forward Yield Spread as a Leading Indicator: A Less Distorted Mirror,” Federal Reserve Board FEDS Working Paper No. 2018-055, July 2018. 18 Muted Inflation 19 Inflation expectations remain below target • The FOMC has a stated inflation target of 2%. o The inflation target is in terms of the annual change in the price index for personal consumption expenditures (PCE). o The FOMC often uses the core PCE inflation rate to gauge inflation performance. • Both inflation and inflation expectations are below target. • This is occurring despite more than two years of upside surprise on the • real growth rate of the U.S. economy. Insurance rate cuts may help re-center inflation and inflation expectations at the 2% target sooner than otherwise. 20 Inflation and inflation expectations low Sources: Bureau of Economic Analysis, Federal Reserve Bank of Cleveland and author’s calculations. I subtract 30 basis points from expected CPI inflation to roughly translate to a PCE inflation basis. Last observations: August 2019 and October 2019. 21 A Turnaround in U.S. Monetary Policy 22 U.S. monetary policy in 2019 • The FOMC has been cognizant of these developing downside risks. • During the first half of 2019, the FOMC began to project fewer • • • increases in the policy rate and also laid out a plan to cease the runoff of the Fed’s balance sheet. On June 19, the FOMC did not change the policy rate but strongly suggested that a future downward adjustment could be warranted. On July 31, the FOMC followed through and reduced the policy rate. On Sept. 18, the FOMC made an additional reduction in the policy rate. 23 Interest rates are dramatically lower • What was the effect of this turnaround in U.S. monetary policy? • The effect has been much larger than the two latest rate reductions alone • would suggest because the expectation as of late last year was that the FOMC would actually raise rates further in 2019. The following chart captures more of the true magnitude of the change in policy during 2019. 24 Effects of the change in monetary policy Source: Federal Reserve Board. Last observation: Oct. 11, 2019. 25 Interpretation • One straightforward reading of these events is that the outlook for • • • shorter-term interest rates influenced by the FOMC, as embodied in the two-year yield, dropped by 135 basis points during the last 11 months because of FOMC actions. This is a very large change over this time frame. Furthermore, these policy actions fed through to longer-term U.S. yields, which are more important for investment decisions. The bottom line is that U.S. monetary policy is considerably more accommodative today than it was as of late last year. 26 Conclusion 27 U.S. monetary policy today • The FOMC continues to face a slowing U.S. economy with some • • • downside risk due to ongoing global trade regime uncertainty. Meanwhile, U.S. inflation and inflation expectations continue to fall short of the FOMC’s 2% target. The FOMC has taken actions that have changed the outlook for shorter-term U.S. interest rates considerably over the last 11 months, ultimately providing more accommodation to the economy. The FOMC may choose to provide additional accommodation going forward, but decisions will be made on a meeting-by-meeting basis. 28 Connect With Us James Bullard stlouisfed.org/from-the-president STLOUISFED.ORG Federal Reserve Economic Data (FRED) Thousands of data series, millions of users SOCIAL MEDIA Blogs and Publications News and views about the economy and the Fed Economic Education Resources For every stage of life Community Development Promoting financial stability of families, neighborhoods ECONOMY MUSEUM 29